Building a great Bitcoin exchange, part I: transaction fees

[Rodyland]

I just had a lightbulb moment.  Sorry for the long post.

I think one of the reasons we're having these sorts of troubles with exchanges is that people (in general) think "exchange" when they really mean "e-trade".  Let me explain (and if you already know what I mean, skip to the last paragraph).

An exchange doesn't deal with everyone and anyone.  It only deals with registered participants (a.k.a. members).  It costs a _lot_ of money to be an exchange member, and it's a lot of work.  The only people that can execute on the exchange are members.  For every order a member executes, that member has to guarantee settlement to the exchange (failure to settle is a big deal).  Members are responsible for _all_ orders they send to the exchange - including orders sent on behalf of that member's clients, including if that member lets someone else "borrow" their exchange connection.  Exchanges take a very dim view on things like market manipulation.  Exchanges usually provide a fairly limited set of order types, for example:
- FOK/IOC (fill or kill/immediate or cancel).  Execute entire order immediately or cancel the order
- Day order (order will be cancelled at the end of the day)
- GTC (good 'til cancelled).  Order lives forever
- Market orders (fill at whatever price necessary)
- Limit orders (fill at a price no worse than that specified)

Anything above and beyond those simple order types is _usually_ provided by the member as a service to their clients, for example:
-  Stop loss orders (you set an order that is inactive until a trigger (eg. trade price) is hit).  Can be used to automatically bail if trend moves against, or automatically take profits if target is hit
- one-cancels-other (two linked orders, the execution of one cancels the other)
- short selling (borrowing stock and selling it)
- algorithmic trading (automatically trading a large order over a period of time to avoid adversely moving the market is one use case)
- dark orders (trading big orders at the mid point of the current bid/offer spread)
[sometimes some of these features are exchange-provided - depends very much on the exchange]

Exchanges hit their members with a range of fees.  Firstly there is just the fee for being a member.  Then there are feeds for the privilege of connecting to the exchange.  In some places a member will be hit with a fee per market action (add/cancel/ammend order).  Of course there are per-execution fees (sometimes flat fees, sometimes % of trade value).   Some places have market maker/taker pricing (ie. if your order is sitting in the book and is taken out by an aggressive order, you get charged differently than if you were the one who crossed the spread and executed) - normally market makers get a discount (or even rebate).  And the exchanges I know of (I work in the field) limit the message (order) rate their members are allowed to do stuff.  If a member wants to send more messages to the market per second, they need to pay more.

The interface (and fees) to the market seen by the member is _very_ different to the interface (and fees) the member presents to their client (eg. your e-trade) account.  And there are good reasons for this - the simpler the exchange interface, the faster it will be, the less prone to errors it will be, the easier it will be to keep track of what's going on, the cheaper it will be (for everyone involved).  Although the "simplicity" of the exchange interface would likely be viewed as complexity by most people who actually want to trade in the market, which is why the exchange members provide their own interfaces that are tailored to their clients (the interface e-trade provides is very different to the one Merrill Lynch provides). 

So now we come to the crux - I believe these exchanges are built and run by people who think that the way e-trade works is the way an exchange works.  If you've ever watched the mtgox ticker and book, the sheer volume of spam trades (BTC0.01 trades) is a symptom of this, as is the sometimes hectic updating of the order book several dollars away from the BBO.  And it's not just gox - they are just the biggest so easiest to pick on.  I believe that building an exchange the way that someone who's only used e-trade thinks an exchange works is why things are so fragile.

So - I commend anyone trying to set up another exchange, and I urge you to do your research and "do it properly".

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[DPoS]

nice post..   but I do think all these extra 'financial instruments' can lead to more problems than their worth

what's next?  naked short selling? 30x leveraged ETFs? 

I think the less wizardry introduced into an exchange will be more stable.  Even if just to bore the degenerates to go back to their casino exchanges

[Rodyland]

nice post..   but I do think all these extra 'financial instruments' can lead to more problems than their worth

what's next?  naked short selling? 30x leveraged ETFs? 

I think the less wizardry introduced into an exchange will be more stable.  Even if just to bore the degenerates to go back to their casino exchanges

IMO naked shorting is nothing short of fraud.  On the plus side, it's not possible with bitcoin - because to sell bitcoin you have to deliver bitcoin.  So if an exchange allowed "naked shorting" then effectively it would be the exchange loaning the bitcoins for sale.

As for leverage and ETFs, nothing is stopping someone today offering ETFs and leverage.  If I'm not mistaken IG markets has just started offering 'something' (CFDs?) on bitcoin prices.

The benefit of bitcoin is the reduced ability for fraud.  If you have a 30x ETF that trades bitcoin and loses, then the only losers are the investors in that ETF and those who loaned funds to that ETF.  I don't see how something like that going broke could affect the wider Bitcoin.  In fact, it could be a positive - the fact that the losses are quarantined to those directly invested surely is a positive in the favour of Bitcoin.

[johnblaze]

bitfloor did it correctly

limit orders should get a fee RETURNED

market orders should pay the fee

[Rodyland]

bitfloor did it correctly

limit orders should get a fee RETURNED

market orders should pay the fee

Or at least passive limit orders (ie. won't execute immediately) are free.

On top of that, order fees should be flat + % (eg. BTC0.01 per trade, plus 0.5%).  That will kill the micro-trading bots.

On top of that, there should be a fee for cancelling short-lived orders.  Say, any order that lived in the book less than 1 minute gets charged BTC0.01 cancellation fee.  You get five free cancels per 24 hours (plenty for fat finger fix-ups), plus for each execution you get a free cancel (so people can actually do trading if they want).  Or something similar that would stop quote-stuffing.

[Seal]

bitfloor did it correctly

limit orders should get a fee RETURNED

market orders should pay the fee

Or at least passive limit orders (ie. won't execute immediately) are free.

On top of that, order fees should be flat + % (eg. BTC0.01 per trade, plus 0.5%).  That will kill the micro-trading bots.

On top of that, there should be a fee for cancelling short-lived orders.  Say, any order that lived in the book less than 1 minute gets charged BTC0.01 cancellation fee.  You get five free cancels per 24 hours (plenty for fat finger fix-ups), plus for each execution you get a free cancel (so people can actually do trading if they want).  Or something similar that would stop quote-stuffing.

Sounds good in practice, but the logic behind the system might be hard to keep track of.

Taking what you've stated in the OP and what btc-e.com does, I think it would be a good idea to charge a small trade fee 0.1% or less and charge a withdrawal fee as well.

Understandably, brokers have to make a profit from somewhere too.

I would also charge a licencing fee for anybody who wants to use the API as developers using these API's are the ones that place the most strain on the system. Thinking out aloud, free for basic use would be a good idea but then $10 or so a month for trade placing will put off kids running 1 cent scalping bots.

[Rodyland]

Sounds good in practice, but the logic behind the system might be hard to keep track of.

Taking what you've stated in the OP and what btc-e.com does, I think it would be a good idea to charge a small trade fee 0.1% or less and charge a withdrawal fee as well.

Understandably, brokers have to make a profit from somewhere too.

I would also charge a licencing fee for anybody who wants to use the API as developers using these API's are the ones that place the most strain on the system. Thinking out aloud, free for basic use would be a good idea but then $10 or so a month for trade placing will put off kids running 1 cent scalping bots.

An API fee is definitely another way to go.  Maybe as well as or instead of some of the other measures.